Tiffany Diamond Lawsuit Showcases an Unattractive Stock

Tiffany (NYSE: TIF) has accused Costco (NASDAQ: COST) of selling counterfeit Tiffany diamonds. It sounds rather shocking, but this isn't the first time either company has run up against the issue of counterfeit merchandise. However, the story also gives plenty of reasons to avoid Tiffany shares right now.

Tiffany chose a cute day to file its lawsuit (happy Valentine's Day, Costco), making heavy allegations about knock-off Tiffany engagement rings showing up under the fluorescent lights and warehouse ambience of Costco stores. Tiffany ponied up for one of the rings, and upon examination, found that the rock didn't include the luxury jeweler's microscopic brand it uses to identify its own diamonds, nor did the platinum band include the Tiffany trademark.

Although Costco discontinued the rings when Tiffany complained in December, Tiffany has still decided to go forward with the lawsuit, claiming the practice had gone on for many years. It's seeking $2 million in damages, as well as information including the number of fake Tiffany rings the retailer had sold and who supplied them so it can demand triple the profit Costco made on the fakes.

There are plenty of reasons for Tiffany to get sensitive right now, and investors should be paying attention to more than where the Tiffany brand may be showing up. The high-end jeweler's all-important holiday quarter recently fell short. That's not Costco's fault, but it should get Tiffany watchers worried. In January, American Express' decision to lay off 5,400 workers implied a chilly prognostication that affects all luxury brands: higher-income consumers have been cutting back.

In even more difficult news, Tiffany said in its most recent 10-K that the engagement segment is "particularly and increasingly intense," and its edge is to convey quality. For some, that makes Tiffany look better than companies like Blue Nile (NASDAQ: NILE) , which is a more affordable option for engagement rings. Although Blue Nile also disappointed Wall Street's quarterly expectations in its most recent quarter, its engagement ring sales increased 31%. Maybe some engagement ring shoppers are trading down.

As far as Costco's concerned, it's got a reputation for selling high-end merchandise to eager bargain hunters for a relative steal. Other companies have accused Costco of similar violations. Crocs showed up in Costco stores without Crocs' knowledge in 2008, Calvin Klein accused the retailer of stocking fakes, and some companies have cried copyright infringement, too.

Tiffany rabidly defends its brand as a matter of course, since that is one of its key differentiators to begin with. The company went after eBay in 2004 to try to convince the online auctioneer to get a handle on counterfeit Tiffany merchandise that showed up on the site. Interestingly, Tiffany actually lost the suit when the court put the onus on the manufacturer to keep an eye out for counterfeits on the market.

The precedent in the eBay case, and the fact that Costco has never been materially hurt in similar skirmishes over the years, tells me that Tiffany is barking up the wrong tree -- and that Tiffany investors are, too. The consumer spending environment is nasty, and that overall climate bodes far better for Costco than for Tiffany. Last but not least, when corporations file lawsuits it can be a sign of overall weakness. Regardless of what goes down with Costco, Tiffany shares simply don't have much allure right now.

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Alyce Lomax has no position in any stocks mentioned. The Motley Fool recommends American Express, Blue Nile, Costco Wholesale, and eBay. The Motley Fool owns shares of Costco Wholesale, Crocs, and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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I must admit to being puzzled. Ms Lomax is forever ready to wag a finger at fast food joints' not taking sustainability into account on a fish sandwich, talking darkly about "vice industries", and about "evil" chemical firms (that happened to have improved our lives in many a way) etc, etc ETC.

But here, one of her favorite companies is caught red-handed in peddling fraudulent goods-apparently not for the first time-and she blithely calls the exposure "cute timing" and a "rabid" defense of their turf by Tiffany. I believe that's actually called defending a hard-won reputation for quality earned over a century and a half. She points out Costco stopped selling the ersatz Tiffany diamonds when the whistle blew in December. How nice of them! She then yawns that Costco (no mention of the seeming validity of previous charges brought by companies of good repute) "hasn't been materially hurt by similar such skirmishes". Not a hint of the moral judgement, she brings to previous barbs at various companies.

Then, allow me. This is, if, as it seems, the goods were demonstrably misrepresented as being Tiffany a clear-cut breach of business ethics. Period. It matters not, the successful business model Costco brings to market. Their customer base was exposed to mis-represented, and possibly shoddy goods. Wow, maybe Alyce might even discover that bird labeled turkey in the poultry case at the super store is really condor <g>

Thanks for bringing up a rebuttal to my response to this news. It's a valid one. I didn't specifically mention in the article that I don't believe Costco management would do things like this on purpose, and if a lawsuit brought to light that it does, then that would be a different story.

However, the eBay vs. Tiffany judgment is an important aspect to this and seems to be a significant precedent. Unfortunately I think in a lot of cases there is still a "buyer beware" factor to remember.

However, it's also legitimate to say that if something like this happens too often at Costco, they will lose brand respect and trust in their merchandise, so I should hope they do their best NOT to allow things like this to happen too frequently.